Like any marketplace, trading can see periods of stagnation and low activity during a recession. Depending on what type of asset you are trading, there can be a variety of different factors that play out in real time. Some larger investors, known as retail investors, may use the opportunity to accumulate assets at a cheaper price during a recession. Historically, some have used it to make astonishing profits, which we will look at today in greater detail.
What is a recession?
The textbook definition of a recession is two consecutive quarters of negative growth. One of the main examples is a sharp reduction or stagnation in GDP. As we reach the end of Q4 in 2022, many Western economies are experiencing recession and high inflation.
What is GDP stagnation and high inflation? It’s a serious combination that causes economic uncertainty as governments decide which policies to implement, and what to prioritize when taking action. The situation is projected to continue into 2023, and although inflation is expected to slow, the negative market sentiment is likely to remain for some while.
In the event of slow market growth, central banks will tend to lower interest rates to discourage saving and encourage spending. However, when it is coupled with high inflation, like it currently is throughout the US, UK and Europe, it is a double-edged sword. Lowering interest rates means that people get hit with a double whammy of savings that become worthless and the inability to spend the money they have due to the market downturn.
The big players
When a recession begins to bite, the traders who operate at the top of the ladder aren’t as affected as those lower down. Despite the fact they will often lose a lot more money, they also have a lot more money to invest with. This means they can take greater risks if necessary, and one of the truest and oldest quotes about investing, “it takes money to make money”, continually rings true during market downturns.
George Soros is arguably the most renowned forex trader of all time. During Black Wednesday in 1992, he was reputed to have made over $1bn by shorting the UK pound at the height of the economic uncertainty.
If a market drops sharply enough, many traders will enter it as it will likely bounce back to a more moderate level. This was the case during the 2008 crash, the 2020 crash and the multiple bear and bull markets that the cryptocurrency sector has experienced over the last decade.
The knock-on effect
Institutional investors that operate on behalf of hedge funds, pension funds and investment banks will continue to trade even in the event of major market turbulence. However, as retail investors further down the line begin to feel the pinch, the uncertainty and fear cause people to sell their assets to have liquid cash in times of a recession. In addition, it will cause people to conserve their money instead of placing it into a trading asset.
As the ripple begins to make its way through the market, the doubt creeps in, and it inevitably leads to less activity in investment markets in the long term. The initial impact of the recession could cause institutional investors to get involved, however, once the stagnation bites and more people exit the market, the knock-on effect can cause activity to dwindle.
We aren’t going to claim that trading is a special, recession-proof market. Despite the fact that some traders have made an exceptional profit during this time, in the grand scheme of things, a recession is bad for business. Anything that causes fear and uncertainty is bad for the market. Although there may be a few examples of traders making considerable gains, most will lose money during a serious market downturn.
For example, Michael Burry made hundreds of millions of dollars in 2008 by predicting the housing bubble would burst. However, if we zoom out and look at the wider picture, over $5tn was wiped off the value of stocks, and millions lost their homes and became unemployed.
It was an extremely difficult time for those millions who lost huge portions of their net worth, which is the key thing to take away from today’s piece. Trading is affected just as heavily as other markets during a recession. In the case of the 2008 crash, financial institutions were directly responsible for the crash and kickstarted the recession due to poor regulation and dishonest practices.